Australian Share Market-When Will The Bubble Burst?

Throughout history investment bubbles come and go, and when they go generally people’s hopes and dreams go with them. Often matters are made worse by commentators talking about bubbles in a way that creates fear, when they ought to be helping us understand the bubble before it bursts. Knowing how bubbles work greatly helps your investment decisions, and so we will look at how they work using the Australian share market as a guide.

In simple terms human greed creates bubbles. Once a bubble starts it generally continues to grow until it reaches levels where prices go beyond what people are willing to pay. Finally the price rises are unsustainable and without any real warning the bubble explodes and prices fall.

Bubbles are repeating cycles that run from boom to bust and back to boom. The key is to work out where you are in the current bubble, as to know this reveals when it’s safer to invest and when the risks are high. To explain, let’s look at one complete cycle of the Australian share market and more specifically the All Ordinaries Index (top 500 shares in the Australian share market) from 1987 to 2009.

Phase 1

Following the 87 crash (the bust) into the early 90’s, the Australian share market went into a recovery phase. Few investors wanted shares and so remained largely in cash.

Phase 2

In the 90’s, prices began to rise as company earnings showed improvement and investors were lured into shares through high profile floats like Qantas and Commonwealth Bank.

Phase 3

The Australian share market took a breather from the late 90’s into the 2003 low, as a mid cycle rise is always followed by a temporary slowdown.

Phase 4

From 2003 to 2007 shares in the Australian share market rose strongly on renewed optimism, gaining momentum as it rolled along to eventually reach mass euphoria that fuelled the bubble towards the eventual bust, at which point the smart money exited.

Phase 5

In 2007 and into 2008, hot air starts to leak from the bubble and the Australian share market corrects. Investors see the market as ‘cheap’ and buy in, but reality soon hits hard as company earnings disappoint and announcements reveal the extent of the GFC.

Phase 6

Distressed selling occurs into late 2008, and many investors give up and sell out. This is when the smart money is looking to buy.

So where are we now? I believe the Australian share market is in phase two, with phase three unfolding into 2015 and being shorter this time, with a quick recovery the same year. Given this, the current bubble has a lot further to grow.

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